California on the Brink: Pension Crisis About to Get Worse

A growing number of key California cities are a lot worse off than previously thought, thanks to new changes coming in the way state and local governments must account for their pension costs.

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The pension changes from Moody’s, and separately the Governmental Accounting Standards Board, scheduled for this month, could result in Los Angeles, San Francisco, San Jose, Azusa and Inglewood joining fiscally troubled Stockton and San Bernardino, among others, as severe credit risks. It's all largely due to soaring employee retirement costs, according to new analysis based on the methodology by Bob Williams and his team at State Budget Solution (SBS), a non-partisan organization that studies state budget crises.

The new rules could nearly double California’s unfunded liabilities to $328.6 billion. Moreover, California cities that have already filed for bankruptcy protection, like Stockton and Vallejo, will fall deeper into the red.

Officials in these California cities did not return calls for comment.

Government retiree costs to date have been improperly underreported nationwide to taxpayers, says Moody’s. New government rules in effect at the end of this month from the Governmental Accounting Standards Board seek to fix this problem, which could show California is worse off than expected. A growing number of Senators also now warn these pension costs could result in a taxpayer bailout of the states.

California state officials are slowly waking up to the fact that it is expensive to pay for urban sprawl, as it causes city services to be spread far and wide throughout the state at high taxpayer expense. Talk of “technically bankrupt” or cities in “service insolvency” is growing, whereby cities in California are under delivering on public safety, education, and health services.

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California Dreaming

New standards from Moody’s and new government rules in effect by the end of this month come as cushy pension stories continue to pour out of California.

One retiree in the County of Solano pulls in nearly $371,000 a year in retiree pay. Nearly 12,200 government retirees get $100,000 a year, including 94 city retirees in Stockton.

Moody’s new credit standards for public pensions would nearly double the unfunded liabilities for state and local pension plans in California to $328.6 billion from $128.3 billion, says the California Public Policy Center, based on state data. That cost potentially amounts to $8,600 per state resident, it says.

Moody’s has already placed 30 California cities on review for possible downgrade, including Azusa and Inglewood (for full list, see bottom). California has the second lowest credit rating at Standard & Poor’s of all 50 states; Illinois now has the worst. Moody's new standards would drop the funded status of these plans to 64%, versus a previous estimate of 82%, the Center said.

Outsized pension costs now drive the states’ fiscal crises, even before health reform puts more pressure on the states. Federal aid already amounts to almost 30% of states’ total revenues, the Senate report adds.

“By standard accounting methods, some state pension funds will run out of assets within as little as five years,” the Senate report said. “When the states with the worst pension systems come knocking at Washington’s door for a bailout, it will ultimately be taxpayers in more prudent states who will pay for the recklessness of the negligent states.”

New Rules

The GASB rules will force state and local governments to stop burying their pension costs in their financials, and show investors upfront what they owe.

The new rules would also require governments to report more realistic, lower expected rates of returns on their pension assets, instead of the often overstated returns they now use to paper over holes in their plans blown out by bad investments, among other things. It will not force governments to do more in the way of funding these plans, notes Richard Dreyfuss, senior fellow at the Manhattan Institute’s Center for State and Local Leadership.

Downgrades Coming?

Moody’s Investors Service has revamped its credit assessment methodology for evaluating the health of all public employee retiree benefit systems, which could trigger more downgrades as well.

The California Public Employees' Retirement System, the country’s biggest public pension fund, uses a 7.5% return target. Moody’s says it is lowering the assumed rate of return for all plans to 5.5%.

Downgrades typically increase borrowing costs and can hurt a city’s attempt to borrow in the bond markets. Higher interest rates often result in higher local taxes; spending cuts; or fewer bonds issued.

“These figures signal the desperate need for states and municipalities to begin recognizing the enormous size of their pension obligations,” said SBS President Bob Williams. Los Angeles and San Jose rank down there with Stockton and Vallejo in terms of public pension plan funding levels under Moody’s new rules, Williams says.

Whitney, author of the new book Fate of the States: The New Geography of American Prosperity, tells FOX Business that California is papering over budget holes with gimmicks, like raising taxes retroactively, pushing state expenses onto local towns and cities that can’t afford them, and underfunding their pension funds.

“It’s so much worse than the rosy picture that the headlines suggest,” the CEO of Meredith Whitney Advisory group says.

The Senate Joint Economic Committee reiterates what Whitney says. “Many states and localities have regularly skipped or underfunded contributions to pension plans,” the report said. “Over the past five years, state and local governments have underpaid actuarially required pension contributions by more than $50 billion. The worst culprit of all, Illinois, has underpaid its pension contributions to the tune of $28 billion over the past 15 years.”

Illinois’ plan is just 44% funded, or 30% using “conventional accounting standards,” the Senate committee says.

Late last year, Democrat California Gov. Jerry Brown signed into law cuts in government pensions, which he dubbed the "biggest rollback” in the history of the state. Public employee unions are suing to stop the cuts. The majority of the cuts hits new hires, and are forecasted to save as much as $55 billion over the next three decades. However, the cuts won’t do enough to immediately stop the ballooning unfunded liability.

Los Angeles

Pension funds for government workers in Los Angeles could be hit hard. The funded status of Los Angeles’ three retiree plans would drop dramatically under the new rules. Los Angeles’ combined plans would fall from 77% funded to 50% funded, SBS found. The city says it has $31.8 billion in combined assets for all its plans, and that it owes $41.1 billion in benefits for its government workers.

But under the new methodology, the city would owe about $23 billion more to retirees not backed by assets, SBS says.

San Jose

San Jose’s combined plans would fall from 75% to 60% funded, SBS found. The city says it has $4.5 billion in combined assets for its plans, and that it owes $6 billion in benefits for its government workers. But under the new methodology, the city would owe about $1.5 billion more to retirees not backed by assets, SBS says.

Despite the profits from Silicon Valley's technology companies, the city has run 11 consecutive general fund deficits, reports indicate. Standard & Poor's downgraded San Jose's credit rating last year and gave it a negative outlook, saying it still faces "long-term structural pressures.''

To date the city has slashed workers' pay 10% but is still running deficits. City officials have said government worker retiree costs are a big problem, with attempted cuts challenged in court by unions. "Long-term budget obligations have outgrown the current revenue structure,'' Standard & Poor's has said.

San Francisco

San Francisco’s combined plans would fall from 88% funded to 69% funded, SBS says. The municipality says it has $17.1 billion in combined assets for all its plans, and that it owes $19.5 billion in benefits for its government workers. But under the new methodology, the city would owe about $5.3 billion more to retirees not backed by assets, SBS analysis shows.

Azusa

Pension funds for government workers in Azusa, which sits east of Los Angeles, would fall from 88% funded to 70% funded, State Budget Solutions found.

The city says it has $163 million in combined assets for all its plans, and that it owes $186 million in benefits for its government workers. But under the new methodology, the city would owe about $47 million more to retirees not backed by assets, SBS says.

Standard & Poor's has a negative outlook on Azusa, as the city faces an eroding general fund reserve account. Reports indicate it fell to just $50,000, or 0.17% of expenses, last August. Where did its money go? Reports indicate city audits found the city's general fund balance was almost entirely in restricted land assets.

Inglewood

Inglewood’s combined plans would fall from 89% funded to 71% funded, SBS says. The city says it has $575 million in combined assets for all its plans, and that it owes $644 million in benefits for its government workers. But under the new methodology, the city would owe about $161 million more to retirees not backed by assets, SBS found.

Stockton

The city says it has $1.2 billion in combined assets for all its plans, and that it owes $1.4 billion in benefits for its government workers. But under the new methodology, the city owes about $343 million more to retirees not backed by assets, SBS says.

Vallejo

The city says it has $441 million in combined assets for all its plans, and that it owes $587 million in benefits for its government workers. But under the new methodology, the city owes about $147 million more to retirees not backed by assets.